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Municipal Bonds To Get A Boost In India, Should You Invest? - Outside View by PersonalFN

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Municipal Bonds To Get A Boost In India, Should You Invest?
Mar 26, 2015

The NDA Government has set an ambitious target of developing 100 smart cities. However, as rightly quoted by the mayor of Amsterdam Eberhard Van Der Laan, "A smart city is a city where social and technological infrastructure and solutions facilitate and accelerate sustainable economic growth." Netherlands has inked an agreement with India for sharing knowledge in some key areas essential for developing smart cities. Going by the above given description of smart cities; current state of Indian cities may not appear very encouraging. Indian cities are infamous for traffic congestion, inadequate civil amenities and poor state of infrastructure. Besides, lack of planning, inadequate finance is one of the primary reasons why Indian cities lag in the race of world class cities.

India has been witnessing rapid urbanisation for past few decades. As per census 2011 data, about 31% of India's population is urbanised. There were only 12 cities in 1981 with population of more than 10 lakh. However, the number grew to 53 in 2011. As per McKinsey Study (2010) on Indian urbanization projects, India would need to invest around USD 1.2 trillion in urban infrastructure for 20 years between 2011 and 2030.

"Municipal Finance in India - An Assessment", a document published by the Reserve Bank of India (RBI) in 2008, has highlighted financing problems faced by the municipalities. Given the substantially inadequate income streams and limitations on getting government assistance makes it difficult for municipal corporations to function effectively. RBI also suggested some reforms. As a remedial measure, RBI had suggested that, the borrowing restrictions on Urban Local Bodies (ULBs) should be eased. Furthermore, it also suggested some financing options for municipalities including, municipal bond, specialised municipal funds and public-private partnerships.

A few municipal corporations have issued bonds in the past but it's a fact that, at present, the municipal bond market is extremely underdeveloped in India.

Soon the situation might change for better. Securities and Exchange Board of India (SEBI) has recently issued fresh guidelines governing the municipal bond market. Let's see how municipalities may benefit from new norms.

  • There may be an additional funding source for municipal corporations

  • Disclosure norms for municipalities may get better

  • Listing of bonds on exchanges may help deepen the market allowing issuers discover right price for meeting capital requirements
It is noteworthy that, to issue municipal bonds, there is no more a requirement of carrying a credit rating of "A+". The credit rating of "BBB-"would also suffice. Due to this many municipal corporations may now be able to issue bonds. Now the question is how safe would it be to invest in bonds with a credit rating just a notch above that of bonds with "junk status"? SEBI has tried to take care of risk-related issues by issuing precautionary norms such as;
  • Public issue should consist of revenue-generating bonds only - i.e. bonds which are served with revenues generated by some income generating project

  • Bonds should have a minimum tenure of 3 years

  • The issuer shall create a separate escrow account for servicing of debt securities with earmarked revenue

  • Municipality issuing bonds shouldn't have a negative net worth in 3 years immediately preceding the year in which the bonds are issued

  • Municipal Corporation issuing bonds shouldn't have defaulted repayment of debt securities or loans obtained from Banks/Financial Institutions

  • Municipal corporations have also been allowed to issue tax-free bonds. Usually tax free bonds help garner funds at lower coupons
Who can invest in municipal bonds?

Municipal bonds have been very popular in developed markets such as the U.S. In India, municipalities may issue bonds to retail investors as well as institutional investors including sovereign funds, pension funds and insurance companies.

PersonalFN believes that, new norms on municipal bonds would make it possible for larger as well as smaller players to get access to a new debt instrument. Listing of these bonds may ensure adequate liquidity. Considering, crowding of FIIs in G-Sec bonds, municipal bonds may provide them a good alternate avenue which may help development of Indian debt markets as well. Greater financial resources would help municipalities deliver better performance, which is otherwise hindered due to lack of financial support.

PersonalFN is of the view that; as far as investing in these bonds are concerned, investors would be better off paying attention to the credit rating. Although municipal bonds are relatively safe, you shouldn't ignore fundamentals of the issuance completely. Norms requiring municipalities to issue only revenue generating bonds to individual investors should take care of worries related to the debt servicing. Having said this, you must invest in bonds only if your time horizon matches with the tenure of the bonds issued.

As municipalities may be able to raise more money, you can only hope for improvement in infrastructure of cities.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


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